Monday, October 15, 2012

The Economist may have discovered that the right social democratic institutions can achieve equality and efficiency, but the European Union, where social democracy was invented, is running as hard as it can in the opposite direction. Witness Olli Rehn's astonishingly reality-challenged assessment of austerity here.

Under the remarkable title 'Europe lays the foundations for growth' Rehn comes up with a series of implausible statements, including 'now is not the time to turn away from policies that have led to this improvement (what improvement?) and that are contributing to a gradual return of confidence in the euro area'. The essence of what Rehn is saying is that austerity might have negative effects on growth, but that that only 'merits further study', and that basically the PIIGS are in a mess because of their own economic weaknesses, and the crisis is nothing to do with EU or ECB policy.

So a debt boom in the mid-2000s had nothing to do with the ECB adopting a policy that gave monetary stimulus to Germany whilst giving the Eurozone periphery negative real interest rates. OK then.

Rehn, of course, as a Finn should know something about social democracy. He should also remember the financial crisis and employment shocks suffered by Nordic countries in the 1990s. But luckily for Finland, they were able to address these problems whilst the rest of Europe was growing, so Spaniards and Greeks had some cash to buy Nokia mobile phones (does Finland make anything else?).

Spain and Greece will have to manage on their own. That they are ill-equipped to do that is hard to miss at this point. Once again, Nobel-prize winning Europe is not up to the task. If the EU survives all this in anything like its current shape, it will be a miracle.

Interesting to see The Economist lauding Sweden: The new model. Sweden has a generous welfare state, strong trade unions, and high living standards. What's more, at the moment Sweden is one of the few advanced democracies that is growing and has a budget surplus. So it's about time some of the mainstream commentariat starting to notice what was going on.

In fact Sweden is not really an outlier or an exception. If we look around the advanced democracies, the best performing countries have been those with the most generous welfare states and most entrenched trade unions (Sweden, Netherlands, Finland, and of course Germany). In contrast the countries with deregulated financial markets, weak trade unions and limited welfare states are mostly suffering, and the PIIGS of the Eurozone periphery, despite popular myth, also have weak unions and patchy social coverage.

So the crisis, in fact, has exposed the bankruptcy of the free market, anti-social model that has dominated politics and economic policy since the 1980s. Strangely, political leaders have failed to catch on, and continue to plug the same snake oil, in the guise of 'structural reform', which has brought disaster. The misery of the current recession, instead of sparking a search for equitable solutions, has instead led to a descent into masochistic and self-defeating austerity policies, with a bit of free market liberalism thrown in. After 2-3 years of this medicine has failed to turn around any of the economies it has been applied in, a rethink is overdue. Unfortunately it will probably take total social breakdown (probably in Greece and/or Spain) before the humble pie is consumed.

Monday, October 1, 2012

One thing we have learned so far in the Great Recession is that stress tests for banks are pretty much a waste of time, because nobody seems to take them that seriously. Like all other estimates of the depth of our financial crisis, the stress tests understate the scale of banking losses and overstate their ability to withstand further shocks. Current estimates of Spanish banks' shortfall - around 60 billion euros - are scarcely believable, given that the collapse of the housing bubble in Ireland - a country with a tenth of the population of Spain, was over 50 billion. So much for stress tests for banks.

But we are doing quite a lot better at stress-testing the democratic regimes of periphery countries. Yes, that's right, those countries with the most recent experience of dictatorship, the ones whose democracies are scarcely two generations old. Greece, Spain and Portugal began the 1970s, the last great economic crisis, as authoritarian regimes of varying degrees of brutality. By the time the years of stagflation were over, dictators had been booted out of all three countries and replaced by democracies which, on the whole, have been as successful as anyone observing events in the 1970s could have hoped.

Until now. Unemployment of 25% in Spain and Greece, well over 50% youth unemployment, a total GDP contraction in Greece of 25% since 2007, and more austerity to come.

I'm still pretty confident of democracy in Spain and, as far as I can tell, Portugal. And I think Italy, with all its huge failings as a political system, has far too powerful a democratic majority to regress to where it was in the 1930s.

But Greece, I have to say, really worries me now. Stories of the police referring citizens to the viligante arm of Golden Dawn, and the recent polls placing the thugs as third party ahead of PASOK, set my hair on end. In Spain, democracy is being stressed in different ways - not only on the streets, with increasingly tense demonstrations by the real victims of the crisis, the young (and a nostalgically brutal response by the police), but also with the Catalan challenge to the 1978 constitutional settlement, which has the potential to create political chaos.

Not only are we unlearning the economic lessons of the 1930s, as Paul Krugman keeps reminding us, we are also unlearning the political ones. When placed in an impossible situation, there is no guarantee voters will respond with trusting patience in the established elites when there are political entrepreneurs out there with easy solutions to their problems. So far, only Angela Merkel amongst major European leaders has survived an election since 2008. In Greece, rapid turnover has decimated the party system and opened up a huge space for the worst kind of racist nationalist demagoguery. And the worst thing is, that the mainstream parties are, generally speaking, at a loss to respond to the crisis, so we can hardly blame people for turning to the alternative.